In the FT article, Bezemer writes:
From the beginning of the credit crisis and ensuing recession, it has become conventional wisdom that "no one saw this coming." .....
.... in fact, many had seen it coming for years. They were ignored by an establishment that, as the former Federal Reserve chairman Alan Greenspan professed in his October 2008 testimony to Congress, watched with "shocked disbelief" as its "whole intellectual edifice collapsed in the summer [of 2007]." Official models missed the crisis not because the conditions were so unusual, as we are often told. They missed it by design. It is impossible to warn against a debt deflation recession in a model world where debt does not exist. This is the world our policymakers have been living in. They urgently need to change habitat.
It's worth noting that they also live in a world where global warming cannot destroy the world economy. So the corrections that are needed in light of the financial crash may well not be the last word. Rather, they should be thought of as a first draft, or a template for further rethinking that needs to be done.
I undertook a study of the models used by those who did see it coming.* They include Kurt Richebächer, an investment newsletter writer, who wrote in 2001 that "the new housing bubble-together with the bond and stock bubbles-will [inevitably] implode in the foreseeable future, plunging the US economy into a protracted, deep recession"; and in 2006, when the housing market turned, that "all remaining questions pertain solely to [the] speed, depth and duration of the economy's downturn." Wynne Godley of the Levy Economics Institute wrote in 2006 that "the small slowdown in the rate at which US household debt levels are rising resulting from the house price decline, will immediately lead to a sustained growth recession before 2010." Michael Hudson of the University of Missouri wrote in 2006 that "debt deflation will shrink the 'real' economy, drive down real wages, and push our debt-ridden economy into Japan-style stagnation or worse." Importantly, these and other analysts not only foresaw and timed the end of the credit boom, but also perceived this would inevitably produce recession in the US. How did they do it?
Before going on to his answer, I'd like to present the following table, reformatted from his paper, showing all the people he found who saw it coming:
| Analyst | Capacity | Forecast |
| Dean Baker, US | co-director, Center for
Economic and Policy Research
| " ...plunging housing investment will likely push the economy into
recession." (2006) |
| Wynne Godley, US | Distinguished Scholar,
Levy Economics Institute of Bard College
| "The small slowdown in the rate at which US household debt levels are
rising resulting form the house price decline, will immediately lead to
a ...sustained growth recession ... before 2010". (2006). "Unemployment
[will] start to rise significantly and does not come down again." (2007) |
| Fred Harrison, UK | Economic
commentator
| "The next property market tipping point is due at end of 2007 or early
2008 ...The only way prices can be brought back to affordable levels is a
slump or recession" (2005). |
| Michael Hudson, US | professor, University
of Missouri
| "Debt deflation will shrink the "real" economy, drive down real wages, and
push our debt-ridden economy into Japan-style stagnation or worse."
(2006) |
| Eric Janszen, US | investor and iTulip
commentator
| "The US will enter a recession within years" (2006). "US stock markets are
likely to begin in 2008 to experience a "Debt Deflation Bear Market"
(2007) |
| Stephen Keen, Australia | associate professor,
University of Western Sydney
| "Long before we manage to reverse the current rise in debt, the economy
will be in a recession. On current data, we may already be in one." (2006) |
Jakob Brøchner Madsen &
Jens Kjaer Sørensen,
Denmark | professor &
graduate student,
Copenhagen
University
| "We are seeing large bubbles and if they bust, there is no backup. The
outlook is very bad" (2005)" The bursting of this housing bubble will have
a severe impact on the world economy and may even result in a recession"
(2006). |
| Kurt Richebächer, US | private consultant and
investment newsletter writer
| "The new housing bubble - together with the bond and stock bubbles - will
invariably implode in the foreseeable future, plunging the U.S. economy
into a protracted, deep recession" (2001). "A recession and bear market in
asset prices are inevitable for the U.S. economy... All remaining questions
pertain solely to speed, depth and duration of the economy's downturn."
(2006) |
| Nouriel Roubini, US | professor, New York
University
| "Real home prices are likely to fall at least 30% over the next 3
years"(2005). "By itself this house price slump is enough to trigger a US
recession." (2006) |
| Peter Schiff , US | stock broker,
investment adviser
and commentator
| "[t]he United States economy is like the Titanic ...I see a real financial
crisis coming for the United States." (2006). "There will be an economic
collapse" (2007). |
| Robert Shiller, US | professor, Yale
University
| "There is significant risk of a very bad period, with rising default and
foreclosures, serious trouble in financial markets, and a possible recession sooner than most of us expected." (2006) |
Continuing in his FT story, Bezemer writes:
Central to the contrarians' thinking is an accounting of financial flows (of credit, interest, profit and wages) and stocks (debt and wealth) in the economy, as well as a sharp distinction between the real economy and the financial sector (including property). In these "flow-of-funds" models, liquidity generated in the financial sector flows to companies, households and the government as they borrow. This may facilitate fixed-capital investment, production and consumption, but also asset-price inflation and debt growth. Liquidity returns to the financial sector as investment or in debt service and fees.
It follows that there is a trade-off in the use of credit, so that financial investment may crowd out the financing of production. A second key insight is that, since the economy's assets and liabilities must balance, growing financial asset markets find their counterpart in a growing debt burden. They also swell payment flows of debt service and financial fees. Flow-of-funds models quantify the sustainability of the debt burden and the financial sector's drain on the real economy. This allows their users to foresee when finance's relation to the real economy turns from supportive to extractive, and when a breaking point will be reached.
This is sort of like being told that a certain kind of car has a speedometer, so that you can tell when you're breaking the law-and more importantly, when you're driving so fast you could be in danger of breaking your neck. "Big deal," you might think. "But don't all cars have those? And besides, you can just see that sort of thing if you're really paying attention." But the thing is, most economists use models that don't have speedometers. And driving an economy is not quite like driving a car. That's where the analogy breaks down-so badly that it needs to be junked. So you can't so easily see how things are going. Or as Bezemer puts it:
Such calculations are conspicuous by their absence in official forecasters' models in the US, the UK and the Organisation for Economic Co-operation and Development. In line with mainstream economic theory, balance sheet variables are assumed to adapt automatically to changes in the real economy, and can thus be safely omitted. This practice ignores the fact that in most advanced economies, financial sector turnover is many times larger than total gross domestic product; or that growth in the US and UK has been finance-driven since the turn of the millennium.
In his longer paper, Bezemer presents diagrams of what the two sorts of models look like. First is the flow-of-funds model-taken from Hudson, who, btw, was Denis Kucinich's economic adviser in his presidential campaign:
[Click to Enlarge in New Window]
Next is a quintessential versions of the standard macro model:
[Click to Enlarge in New Window]
This is only a very cursory introduction to Bezemer's analysis. But I've already loaded folks up with plenty of economics this weekend, so I'm going to hold off a deeper examination until next weekend. Go look at the originals for more to chew on until then. |
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